On May 12, 2017, MBAF released an advisory addressing changes under the new revenue recognition standard (Topic 606) and the steps that organizations should consider as they develop implementation plans (MBAF’s Topic 606 Advisory). Today, as many companies are undergoing the implementation process to adopt the new revenue recognition standard, MBAF would like to take the opportunity to remind you that the SEC and the PCAOB will be looking closely to ensure that the enhanced disclosure requirements (including in the quarterly reporting leading to the adoption) and the impact on internal controls and related process documentation are appropriately addressed as part of the implementation. Changes required to accounting policies should also be addressed.
What You Should Consider
Based on the new revenue recognition standard, the disclosures pertaining to revenue have significantly changed. More specifically, the new standard requires for information pertaining to the following areas, among others, to be disclosed:
- Significant estimates and judgments – Organizations will need to include qualitative and quantitative information pertaining to how significant estimates were calculated and the significant judgments that were applied as part of recognizing revenue.
- Disaggregation of revenue – Revenue categories should be created, which reflect how the nature, timing and uncertainty of cash flows are impacted by economic factors. As the level of disaggregation required can differ by organization, management teams will need to apply significant judgment in determining the appropriate categories.
- Performance obligations – Disclosures should be made to explain quantitative and qualitative information about performance obligations. A constant criticism heard about the old standard was the boilerplate nature of disclosures, specifically performance obligations. Qualitative items include: (a) warranties and returns; (b) important payment terms; (c) nature of goods and/or services promised; and (d) when performance obligations will be satisfied.
- Asset and liabilities recognized based on contracts – Information pertaining to assets and liabilities that were recognized in order to obtain or fulfill a contract needs to be disclosed. Also, changes in these assets or liabilities during the reporting period need to be disclosed.
- Contract balances – Organizations will need disclose how the trends or changes associated with contract assets (i.e., unbilled revenue) will be transferred to accounts receivable or collected during the period. Disclosure about how contract liabilities (i.e., deferred revenue) will be recognized as revenue during the period is also required.
As the new disclosure requirements are an important factor of the new revenue recognition standard for investors, adequate time and resources should be devoted to address them. In many cases, the information now required may not be readily available or may require coordination with various parts of the organization. As such, it is critical to be proactive and to consider the impact now.
We remind registrants that under Staff Accounting Bulletin (SAB) No. 74 (Topic 11-M), public companies have the responsibility to disclose the impact of final FASB standards that have been issued, but not yet adopted. The SEC staff expects disclosures to include a description of the effect of the accounting policies that registrants expect to apply, if determined, and a comparison with the current accounting policies. If the effect of the adoption is not known or reasonably estimable, registrants should consider additional qualitative financial statement disclosures to assist investors and other users of the financial statements in determining the significance of the effect that Topic 606 will have on the financial statements once adopted. In the quarterly reporting leading up to the adoption of Topic 606, registrants should describe their progress in implementing Topic 606 and the significant implementation matters that they still need to address.
We also remind registrants, as the second quarter reporting for calendar year companies is underway, that they should enhance the SAB No. 74 disclosures with each quarterly period leading to the adoption of Topic 606.
As the accounting principles pertaining to revenue are changing, so should the related accounting policies, where applicable. Organizations will need to analyze their accounting policies that can be impacted as a result of Topic 606 and pin-point where the changes are needed. Once the identification process is complete, as a second step, the respective accounting policies should be updated to include the changes that will be adopted and should accurately reflect the new revenue recognition standard. After the relevant accounting policies are updated, both management and internal audit should review the updated policies to ensure that changes were appropriately addressed and that the documentation is accurate. The changes should also be discussed with your external auditor.
Internal Controls and Process Documentation
With changes being made to the way revenue is recognized and disclosed, it is necessary to consider the impact of the new standard on internal controls. External audit teams will be evaluating to see if changes were made to the existing internal controls that specifically address the new standard. Control descriptions should be modified to address the changes, and in many cases, new controls will need to be added to address the specific changes per the standard. As new information may need to be gathered as result of the control updates and additions, procedures over the completeness and reliability of the new information will need to be evaluated and executed accordingly.
In addition to data validation procedures, process documentation related to the evaluation of internal controls will need to be updated. This can include business process narratives and process flowcharts, which typically demonstrate how financial information moves throughout an organization’s IT systems, manual processes, and internal controls. External auditors often review business process narratives and process flowcharts as part of their SOX assessments, so it is critical to make sure these are not overlooked.
From what we have observed, with the rigorous focus on implementation, it is easy to lose sight of the need to update internal controls and process documentation. It is imperative, however, that management teams coordinate with their internal audit functions to ensure the necessary changes are made.
In recent news, the SEC announced that certain public business entities would be able to use non-public business entity effective dates for adopting Topic 606. This means that instead of adopting the standard for the fiscal year beginning after December 15, 2017, certain companies can choose to adopt the standard for the fiscal year after December 15, 2018.
The SEC further provided; however, that the option to use non-public business entity effective dates is only available to those public business entities that would not meet the definition of a public business entity except for a requirement to include the organizations financial statements or financial information in another entity’s fillings with the SEC. In this context, a company that is a significant equity-method investee to an investor that is required to submit SEC filings, where the investor is required to include the investee’s financial statements in its SEC filings, will not be required to use the public business entity effective date for Topic 606. Other public business entities, not fitting the profile described above, will still be required to adopt Topic 606 under the effective dates previously established for public business entities.
How We Can Help
By selecting MBAF to advise management with the adoption of the new revenue recognition standard, your company will benefit from our experience, which will prove to be the most effective and efficient way to achieve compliance and have the least amount of impact on your current resources.
Although not an all-inclusive list, below are some of the ways we can help.
- Deliver a full implementation on an outsourced basis, including quantification of impact based on transition method.
- Deliver training sessions for your team to explain the changes stemming from the new standard and the impact on disclosures, accounting policies, and internal controls and process documentation.
- Perform a gap analysis for the provisions of the new standard and disclosure requirements.
- Prepare disclosures for the first financial statements using the new standard.
- Identify which existing accounting policies will be affected by the Topic 606 implementation.
- Develop and document new policies or modify existing accounting policies related to revenue recognition.
- Assist with the design and documentation of business process changes, including process narratives, flowcharts, and internal control over financial reporting.